In anticipating the price impact on diesel prices from the launch of IMO 2020 on January 1 – with any impacts expected to start before that – most forecasters have been fairly moderate in their outlook, with some exceptions.
But Fitch Solutions, part of Fitch Ratings, recently came out with its forecast. Prominent in the title is the ‘S’ word – spike.
“Diesel: Tighter Shipping Rules to Lead Large Price Spike in 2020” is the title of the report.
The report as a whole sees the oil market in the next few years as having adequate diesel capacity in general. But it’s the short-term that is of concern to the trucking and transport sector and Fitch’s outlook is stark.
“Fuel switching due to IMO 2020 will drive a large and sudden shift in demand for diesel in shipping, and a significant mismatch between supply and demand, and in turn price volatility appears inevitable during its early stages,” the report said.
There are two paths for diesel to migrate from the current demand pool into meeting demand from the marine sector, which is facing a mandate from the International Maritime Organization to reduce the sulfur content of marine fuel to 0.5 percent sulfur from the current 3.5 percent sulfur cap.
One way is to use an existing product called marine gasoil (MGO), which is a diesel product. The other is to consume a new type of product known as very low sulfur fuel oil (VLSFO). But despite its name, VLSFO will contain a significant amount of diesel molecules, produced using an intermediate product called vacuum gasoil (VGO). VGO is now used to make either finished diesel or gasoline. There are other solutions, such as scrubbers (which allow ships to continue using high sulfur fuel oil) or liquified natural gas (LNG). But it is the MGO vs.VLSFO vs. existing diesel give-and-take that will be key going forward.
IMO 2020 has been described as the most significant environmental regulation ever implemented in the oil industry. It is very different from other new regulations in one key respect – the solution to meeting the new rule will to some degree come from taking products from one stream of products coming from a refinery – the middle distillates – and using them to displace another stream, the fuel oil that is known sometimes as “the bottom of the barrel.” That shift is forecast to be anywhere from 2 million to 2.5 million barrels/day (b/d), a significant amount on a base of about 35 million to 36 million b/d of distillate consumption, including diesel.
According to Fitch, it’s going to be MGO that will win out in the beginning. The move to MGO, Fitch said, is because of “cost, compatibility and regulatory issues associated with conversion to low sulphur fuel oil blends and the installation of scrubbers.”
The report does not predict how big the spike will be. (FreightWaves requested further comment from the authors of the analysis but none were available to speak.)
The agency that has been the most specific in predicting the future price of diesel has been the U.S. Energy Information Administration (EIA). Its forecast is for an increase in the wholesale price of diesel of about 25 cents/gallon while assuming an average 2020 Brent price of $65/barrel and $61/b for WTI. (Prices Tuesday were about $56/b for WTI and $60 for WTI). But there is nothing in the EIA forecast about a price spike.
As mentioned, the long-range Fitch forecast for diesel is for plenty of supply. But it takes time to get there. One point of debate in the oil industry is whether upgrades and capacity additions to the world’s refineries over the past few years will prove adequate for the shift.
The Fitch report says that refineries, particularly in Asia, are undertaking upgrades or are planning to do so in order “to be IMO-compliant by no later than 2021-2022. However, while this would gradually boost the supply of MGO going forward, a significant mismatch between supply and demand, and in turn price volatility, appears inevitable, particularly in the early stages of the policy’s implementation as supply catches up to demand.”
The rest of the report discusses reasons why diesel demand will soften beyond the IMO 2020 switch. After the so-called “Dieselgate” scandal, numerous cities in Europe are looking to ban diesel cars over the next 10 years. Consumption growth in the U.S. will be “subdued, averaging annual growth of just 0.6 percent over 2019-2023 due to the outsized effects of a slowing economy.” Diesel growth rates were 1.6 percent between 2014 and 2018, and 3.3 percent between 2017-2018.
This backdrop comes as there will be “an onslaught of refining capacity additions…well into the next decade.” A shift away from a diesel glut won’t occur until 2026, the Fitch report said.
But that is a long-term view of the market’s structure. It isn’t a verdict on the next several months as IMO 2020 comes into effect.